Bitcoin mining - How the digital gold is mined

4 months ago

Bitcoin mining - How the digital gold is mined

Bitcoin mining is a technically necessary and sometimes controversial process. It has ensured since the beginning of the Bitcoin blockchain that no one is able to forge past transactions, manipulate the money supply or prevent current transactions. However, the idea behind it takes into account not only technological aspects, but also those of game theory.

The basis for all these advantages is a single proof of work that consumes energy and puts the participants, i.e. the miners, in a constant competition for available computing power or the hardware required for it. Yet this very mechanism that drives the entire market is causing social controversy. Top international policy makers are concerned with defining climate targets and, if possible, meeting them. This is diametrically opposed by resource-intensive Bitcoin mining.

In this article, we want to look at the origins of mining, and in addition to how it works and how it came to be, we also want to look at the social implications.

Hashcash: How it all began

The proof of work to be done by miners was not originally thought up by the inventor of Bitcoin at all, but was merely given a new purpose. The actual idea behind it goes back to Adam Back, who thought it up in the 1990s as a system to combat spam.

If, for example, a spammer sends a spam mail to 1 million recipients, then he needs a certain infrastructure to avoid being directly exposed as spam, but he can send such mails comparatively cheaply. The core idea of Hashcash, as Back called his concept at the time, was that every sender had to provide proof of work before being allowed to send anything.

To do this, the sender was supposed to solve a math problem that, while easy to verify, still required a relatively large amount of work to calculate. In this system, if a spammer tried to send 1 million emails, he would be screwed because he would suddenly have to own expensive infrastructure and at the same time consume a lot of electricity. As a result, no one would send spam anymore because the system would punish the spammer and let honest senders of harmless emails operate at a low and acceptable cost.

This idea was transformed into something new by Satoshi Nakamoto, the mysterious inventor of Bitcoin.

The problems of a decentralized ledger

Bitcoin was the first cryptocurrency to solve a problem that could not be handled by a digital technology before. Suppose Bob sends Alice 1 BTC to her wallet, how do you ensure that Bob doesn't simply reverse the transaction? And more importantly, how do you make sure that Bob really only has 1 BTC that he can send and not simply multiply his own account balance?

This is exactly where mining comes in, which uses proof of work to ensure that not just anyone can confirm transactions, but must provide computing power to do so. In the course of this, a protocol has to be followed, which guarantees that no one can manipulate anything. This is achieved by grouping transactions into blocks. Each of these blocks has a so-called hash, which must be included in the creation of the following block.

If a malicious actor were to change even one transaction in a past block, then this block would suddenly receive a different hash value and no longer fit into the continuous chain of blocks. This is where the name of the technology behind Bitcoin comes from, and it has changed the world since its inception.

But why should miners support the blockchain and not try to use their computing power to manipulate or use it for something else entirely? The answer here is rooted in the reward, the socalled block reward. On the one hand, it contributes to the controlled and limited creation of the money supply, but on the other hand, it is also an incentive. If a miner solves a calculation problem and confirms a block, then he is awarded with the block reward. In the end it is payment that makes bitcoin mining attractive.

Bitcoin miners join together in mining pools

Because mining alone is very difficult, miners join together to form individual mining pools. The effect of such an association is that each miner no longer tries to solve the necessary calculation task on his own, but each participant in the pool makes a partial contribution.

In return, he receives only a part of the block reward, which is usually measured according to a certain calculation method and is always directly related to the partial performance. Such a mining pool therefore offers the advantage that the miners receive regular payouts at all, because if they were alone, it could take years to solve even a single block.

In principle, you can even participate with individual computers this way, even if you always have to keep in mind that energy and acquisition costs can only be recouped over a longer period of time.

Bitcoin mining and game theory

As we have shown, miners are rewarded for ensuring that blocks are chained according to a certain protocol. The fact that they have to perform keeps at least the simplest manipulation attempts away.

But what if a participant were to try to compete with so much computing power that they could simply manipulate the course of the blockchain? In theory, this is possible, but to do so, he would have to ensure that he had more than half of the computing power in the entire network and thus a majority.

Since the difficulty of computing a block dynamically adjusts to the entire network of miners, there is no way that he can abruptly dominate everything with a large amount. Still, he may reach the point where he owns more than half the power. But even that would not serve as an incentive. After all, all miners are rewarded for being honest. In other words, what incentive could someone have to incur a gigantic cost just to manipulate a few transactions when they could instead be honest and simply earn Bitcoin?

The relationship between reward and the effort to be expended for the reward or for the manipulation is always in a constellation where the manipulation is the worse outcome for the miner.

But what if one of the participants acts irrationally and simply wants to burn his money? Well, then Bitcoin would have to fork and our fictitious, irrational and malicious and as well powerful miner would have to continue on his own blockchain and would no longer have anything to do with Bitcoin. But it will probably never get to that point, because there are now so many Bitcoin miners that the effort and expense simply cannot be afforded. A person or institution that would willingly waste such an incredible amount of money remains fictitious in the end.

Bitcoin mining and the environment

Bitcoin mining, as we have already explained, consumes an unimaginably large amount of energy. While the network of miners is globally distributed, you could end up feeding a small country with the power consumption. This has sparked a debate in recent years about whether the proof of work of mining is even a viable technology.

This is because miners have a strong incentive to expand the network and ensure that they connect more and more power. Therefore, power consumption increases and hardware also needs to be replaced on a regular basis, which also factors into the environmental impact.

This is where technological assessments come into play first and foremost, in addition to considerations by policymakers and environmentalists. First, there are alternative models for proof of work. These are, for example, proof of stake, which is also to be introduced by Ethereum 2.0 because it is more resource-efficient.

On the other hand, proof of work as operated by Bitcoin miners can be credited with working for 12 years, maintaining equilibrium between competing interests and guaranteeing the security of transactions. Many alternative proofs have not been tried and tested for as long and must first withstand the test of time and may end up not being as secure.

Does bitcoin mining have a future?

In short, yes. Bitcoin is not only the most heavily capitalized cryptocurrency in the global market, but mining has been proven to provide absolute security for all network participants. Environmental protection is also not a strong argument against mining because the biggest problem is not in the consumption of energy, but in its generation.

In Asia, primarily in China, hydropower is a very popular and readily available energy source. As a result, many mining farms already run on green power and also have an intrinsic motivation to seek clean, sustainable and cheap energy. But even where such energy sources are not available, there are excellent alternatives.

That's because even power plants are now moving to use off-peak hours for bitcoin mining. This is because the power cannot really be stored in the long term, but is either diverted or eventually consumed. This results in a relatively high power loss, which, however, has to be accepted for technical reasons. However, if the unneeded surplus is used directly for Bitcoin mining, then none of it is lost, but is directly converted as power for the network and remunerated through "mined" Bitcoins.

In the end, one could even go so far as to simply claim that mankind has a legitimate interest in Bitcoin. After all, the technology serves an important purpose because it enables free and transparent exchange between people all over the world without distinction. In direct comparison, what justification is there for the energy consumption in standby mode of billions of devices around the world? How high is the energy consumption of a streamed movie via Netflix and should the consumption of entertainment media be prioritized in the same way as the energy consumption of a Bitcoin transaction?

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